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Tuesday, May 4, 2010

Commissioner Aguilar Advocates That All Advice-Givers be Subject to the Fiduciary Framework

On April 29, 2010, SEC Commissioner Luis A. Aguilar gave a speech at the Investment Adviser Association Annual Conference in Chicago, Illinois. Commissioner Aguilar’s remarks were directed at financial regulatory reform. In particular, Commissioner Aguilar addressed the need for all providers of investment advice to be subject to a fiduciary duty.

Aguilar looked back to a congressionally mandated report conducted by the SEC of investment companies, investment counsel, and investment advisory services after the enactment of the Investment Advisers Act of 1940. The report stressed that a significant problem in the industry was the existence, either consciously or, more likely, unconsciously, of a prejudice by advisers in favor of their own financial interests.

Aguilar then asked that his audience flash forward from the 1930s to the events of the last two years. He noted that an array of examples comes to mind demonstrating the role that advice tainted by conflicts of interest played in harming investors and harming market integrity. Tainted advice led investors to invest billions of dollars in auction rate securities because brokers told them they were safe investments. Conflicts of interest at credit rating agencies contributed to AAA ratings on products that turned out to be worthless. Clearly, Aguilar noted, the concerns giving rise to the Advisers Act are even more relevant today. In Aguilar’s words: “We need to restore the clear and strong rules that protect investors and, more than ever, we need to ensure that investment advice is disinterested.”

Aguilar noted that the extension of the fiduciary duty to broker-dealers who provide investment advice is the ultimate investor protection issue — because the harm to investors is real if broker-dealers giving advice are not held to the fiduciary standard and fail to put their client's interests before their own. Aguilar noted that if someone is giving investment advice to an investor, regardless of the title on the business card, that person should always be bound to do so in the best interests of the client. While the scope of service may vary between clients, the standards of loyalty and care in providing that service should not.

Aguilar noted that because broker-dealers are not fiduciaries, investors are not required to be informed of possible conflicts that may affect the advice they receive. For example, investors may not be told that the representative sitting across from them may receive undisclosed compensation from the investment option he or she just recommended. Aguilar stated that since many broker-dealers aggressively market themselves as "financial advisers," investors have a difficult time distinguishing them from investment advisers. As a result of this confusion, Aguilar noted that investors will fail to understand that the broker-dealer, unlike an investment adviser, is not required to place their interests first.

Aguilar stated that the danger is not simply that investors are unable to distinguish between broker-dealers and investment advisers; it is that both entities are providing investment advice to investors with dramatically different consequences. Although often marketed in the same way, Aguilar believes that the investment advice that investors receive from broker-dealers does not come with the same protections as advice received from investment advisers.

Aguilar noted that the fiduciary standard guards against the inherent bias that arises when the broker-dealer is focusing on selling a product, rather than focusing only on what is best for a client. Permitting broker-dealers to provide investment advice without requiring them to act as fiduciaries is, in Aguilar's opinion, to permit a practice that undercuts the core principles of the Advisers Acts and leaves investors vulnerable to the same abuses described in the 1930s.

In that regard, Aguilar expressed disappointment in the Senate Bill, which has abandoned its strong position on application of the fiduciary duty standard in the face of determined lobbying by the insurance and brokerage industries. The revised version has eliminated the provision applying the fiduciary standard to brokers who provide investment advice. It would, instead, require a one-year study by the SEC concerning the effectiveness of existing standards for "providing personalized investment advice and recommendations about securities to retail customers."

Aguilar set out the reasons for his disappointment. First, he sees no need to study the effectiveness of existing obligations for investment advisers. He believes the system in place already has a strong, workable standard that has been in use successfully for decades, and he would not support any attempt to weaken it. Second, as with the House Bill, Aguilar questions why the protection of the fiduciary standard should be limited to "retail" customers. He sees it as readily apparent from recent Commission enforcement cases — such as the cases involving auction rate securities — that all investors, including institutional investors, need the protection of the fiduciary standard. Third, Aguilar questions why the study, as well as the reach of the House Bill, should be limited to "personalized services." This qualification would narrow the range of clients that would be protected by the fiduciary standard, and he fears that it may become a loophole that would make it easy to avoid putting clients first.

Finally, Aguilar does not believe that there is a need for an additional study to conclude that protection of investors requires that broker-dealers providing investment advice be subject to fiduciary duties. In his mind that question has long ago been asked and answered. Aguilar believes that we need to remain vigilant to make sure that investors who receive advice do so from intermediaries held to the high standards of care and loyalty embodied in the existing fiduciary standard under the Investment Advisers Act.

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